US/UK: Why responsible companies should pay taxes

Ending the race to the bottom: why responsible companies should pay taxes

US companies such as Walgreen's, Medtronic and others are taking big steps to avoid taxes. It's that time businesses thought about tax as an investment in the future, writes Marc Gunther.

America’s a great country. That’s why people from all over the world — including, lately and tragically, thousands of poor children from Central America — clamor to get in. So why are some of America’s wealthiest companies trying to get out?

It’s simple, really — they don’t want to pay US taxes.

You’ve probably heard about Walgreen’s, your neighborhood pharmacy that is contemplating moving its headquarters to Switzerland to reduce its tax bill. Medtronic, the big medical device company based in Minneapolis, Minnesota, has plans to move to Ireland, for tax-avoidance purposes. Then there’s Mylan, a maker of generic drugs based near Pittsburgh, Pennsylavia, which intends to incorporate in the Netherlands, where the tax rate is lower. Mylan’s CEO, as it happens, is Heather Bresch — the daughter of US Senator Joe Manchin, a West Virginia Democrat — and she says she has no choice but to go.

Other companies aren’t going so far as to relocate their headquarters, a process known as inversion that often requires them to acquire a company based elsewhere. Instead, to avoid US taxes, they are parking their earnings offshore, often in tax havens like Bermuda and the Cayman Islands that levy no corporate income taxes. That tactic, which like the inversions is legal, is being employed by companies that position themselves as good corporate citizens — among them Apple, Coca-Cola, General Electric, Google, Microsoft, Nike and PepsiCo.

But shouldn’t good citizens pay their fair share of taxes? Socially responsible investors and watchdog NGOs say tax avoidance carries risks for companies that care about their reputation, as all companies should.

"It’s short-sighted,” says Adam Kanzer, general counsel and managing director of Domini Social Investments. "Companies like Walgreen’s run the risk of being seen as unpatriotic.” Just two years ago, the Illinois-based drugstore company sought and received tax breaks from the state government, and now it’s ready to leave.

Domini this year filed a shareholder resolution to reform Google's tax-avoidance strategy. It said: "Even if they are within the law, aggressive tax minimization approaches pose regulatory, reputational and financial risks.”

'Tax shaming'

In the UK, Google, Starbucks and Amazon have all been subject to public protests in the form of "tax shaming" for paying little or no taxes. Starbucks subsequently agreed to voluntarily pay £20m in taxes.

Tax shaming has now come to the US. In a cover story — really, more of a rant — in the current issue of Fortune, columnist Allen Sloan writes: "Being legal isn’t the same as being right. If a few companies invert, it’s irritating but no big deal for our society. But mass inversion is a whole other thing, and that’s where we’re heading.”

Only 55 Fortune 500 companies disclose what they would expect to pay in US taxes if these profits were not officially booked offshore. All told, these 55 companies would collectively owe $147.5bn in additional federal taxes. To put this enormous sum in context, it represents more than the entire state budgets of California, Virginia and Indiana combined.

It’s clear from the report that companies are shifting their earnings from the US to tax havens like Bermuda and the Cayman Islands. The report found that subsidiaries of US companies reported earning $94bn in Bermuda, which has a gross domestic product of just $6bn. That doesn’t compute. US firms reported earning another $51bn in the Cayman Islands, where GDP is about $3bn. Ugland House, a five-story office building in the Caymans, is the registered address for a whopping 18,857 companies, the Government Accountability Office found in 2008.

How did we get here?

You may wonder how companies get away with this. That’s complicated, and beyond the scope of this story. (Read the report from Citizens for Tax Justice to find out more.) One popular tactic is to grant patents or intellectual property rights to a subsidiary located in a tax haven, and then pay above-market royalties to that subsidiary, thus shifting profits from a high-tax jurisdiction to a low one.

Some people say high US corporate taxes are driving all this labyrinthine tax avoidance. In fact, the US statutory corporate income rate of 35% is one of the world’s highest, but most companies pay less — how much less is a matter of debate, but a 2013 US Government Accountability Office report pegged the effective tax rate at about 13% on income, 17% including state and local taxes.

What’s more, business pays a smaller proportion of US taxes than it once did. A 2011 report to Congress found:

At its post-WWII peak in 1952, the corporate tax generated 32.1% of all federal tax revenue. In that same year the individual tax accounted for 42.2% of federal revenue, and the payroll tax accounted for 9.7% of revenue. Today, the corporate tax accounts for 8.9% of federal tax revenue, whereas the individual and payroll taxes generate 41.5% and 40.0%, respectively, of federal revenue.

Reversing the inversion

The question remains, what’s a responsible company to do?

Domini’s Adam Kanzer says companies should work to reform the corporate tax system, even if that means paying more taxes.

"Don’t simply follow this race to the bottom,” Kanzer told me. "Think about tax as an investment, not just as an expense.

"Every company benefits from government — from well maintained highways, a well educated workforce, clean water, regulations to make sure your competitors are obeying the rules, a legal system to protect your intellectual property. They are actually getting a return on their investment.”

Dan Smith, a tax and budget advocate with US PIRG, says: "The first thing that companies should do is disclose. If all the information about companies’ tax strategies was available to the public and to lawmakers, it would be clear there’s a big problem.” Already, he says, "there’s broad agreement that some of the worst dodges need to be done away with”.

Rebecca Wilkins of Citizens for Tax Justice says companies need to take it upon themselves to resist tax dodges. She formerly worked at auditing firm KPMG and says: "You sit across the table from a client, and they know when it’s too aggressive, and a lot of clients would decline to participate.” The big accounting firms have a role to play, too. "It’s really frustrating to see a lot of people in the tax industry encouraging this conduct,” she says.

One tactic that probably won’t work: Shareholder resolutions like the one filed at Google. It received just 1% of the vote.

WHY REGISTER WITH SAIT?

Section 240A of the Tax Administration Act, 2011 (as amended) requires that all tax practitioners register with a recognized controlling body before 1 July 2013. It is a criminal offense to not register with both a recognized controlling body and SARS.

MINIMUM REQUIREMENTS TO REGISTER

The Act requires that a minimum academic and practical requirments be set to register with a controlling body. Click here for the minimum requirements of SAIT.